Personal Finance

Understanding Debt and how to Avoid the Debt Trap

With the recession in recent years and the crash of housing markets all over the world, debt is a hot topic; but what are the different types of debt and how can you avoid being trapped in debt for years to come?


The Definition of Debt

Google defines debt as:

“ Noun – Something, typically money, that is owed or due; the state of owing money.”

Although debt can include other types of owing than money, say as in a favor, the main focus of the debt definition that will be used here is in regard to financial transactions.

Types of Financial Debt

There are different types of financial debt, the main difference being in the length of the term of the loan. i.e. long term or short term debt. Then there are high debt and low debt which in the business world mean you are aggressive with your financial tactics and are typically a higher risk, whereas low debt would indicate the opposite.

  • Long term debt – is usually accrued through the process of buying a home or car, college student loans, or any other purchase that would take longer than a year to pay off. This type of debt is difficult to avoid entirely if you plan on going to college and don’t have a substantial college fund, plan on purchasing a home or car, or maybe even planning to open a business. But it can be minimalized through saving, budgeting, and strategic planning towards your goals.image2
  • Short term debt - is any loan that must be paid back within the upcoming twelve months. This is usually incurred through more immediate purchases like an unexpected plumbing repair that you pay off on credit through the plumbing company, or a lower amount loan that should only take 12 months to pay off.
  • Secured VS Unsecured Debt – Secured debt is any type of debt that has property linked to it that can be repossessed such as a car, a motorcycle, or a house. Unsecured debt is credit that includes credit cards, gas cards, and the type of credit that have nothing to take back if you default on your loan.

What Debt Means to you

image3It is important to understand the different types of debt and what kind of debt you have in order to maintain a financially healthy lifestyle. The type of debt combined with your debt to income ratio are what financial institutions like mortgage companies and credit card companies use when determining if they will extend credit to you. If you have too high of debt to income ration or too much long term debt you may be seen as a higher risk factor due to how much you already owe. Whereas if you have more income than debt, or fewer long term debt accounts you are likely to be seen as a safer risk.

image4Managing your debt and the kind of debt you have can be challenging, especially if like most people you are living paycheck to paycheck. You don’t have to spend your life stuck in the debt trap, if you pay attention to your debt to income ration, and work towards paying of long term unsecured debt such as credit cards.